CREDIT MANAGEMENT

( Objectives &
Principles)
C&SME Sessions. 3-4
 Importance of Credit Management
• Banks lend the funds raised by them from public by way of deposits.
• Bank deposits are repayable on demand
• Banks shall get back the principal amount of the loans together with
interest, so that they can repay the deposits with interest to the
depositors and balance if any to meet the administrative / overhead
expenses and to retain surplus further if any as profit
• Hence Bank, shall exercise due diligence in lending activities.
• If loans are not recovered on the due dates, banks have to classify such
loan accounts as non-performing assets and make provision for them,
as per RBI’s Income recognition and Asset classification norms.
 OBJECTIVES OF CREDIT
MANAGEMENT
1. Credit Allocation. Different types of loans and advances.
2. Credit Evaluation. Cardinal principles of lending , 6 Cs and 4 Ps
3. Credit Discipline. Pricing , Renewal.
4. Credit Monitoring. Preventive, Remedial & Legal measures of recovery.
Credit Allocation
Classification of Advances
CLASSIFICATION OF LOANS AND ADVANCES
FUND BASED NON-FUND BASED
CREDIT FACILITIES CREDIT FACILITIES

• TERM LOANS • LETTER OF CREDIT

• CASH CREDIT/ OVERDRAFTS • BANK GUARANTEE
• BILLS FINANCE
 Classification of Credit Facilities
In case of fund-based credit facilities, bank parts with the funds to the borrower, immediately. There is an outflow of cash /
funds from bank to customer. The banker customer relation is Creditor and Debtor. In case of non-fund-based credit
facilities, there is no immediate funds flow between the banker and the customer. In case of letters of credit and Bank
guarantees, bank assures /guarantees payment to a third party on behalf its customer, on happening or non-happening of a
contingency as per the terms of the contract. The banker customer relationship in such cases is agent and principal.
1) Loans and Advances: These loans are repayable in installments. Personal loans, business loans, Housing loans etc.
when these loans are repayable monthly EMI is calculated.
2) Bills Purchased / Discount. When goods are sold on credit, the seller would be out of funds, until the buyer makes
payment. In such cases, to tide over the working capital problems, such sellers take finance from banks against the
goods sold on credit. Banks purchase demand bills and discount usance bills and provide finance to them.
3) Cash Credit & Overdrafts: Cash credit facilities are sanctioned on the stock in trade of a business concern. Overdraft facilities are
sanctioned against any security other than the stock in trade. Normally these limits are sanctioned for 1 year. There after they are
required to be renewed. In cash credit / Overdraft account, the borrower is given a specific credit limit. The borrower is permitted to
draw amounts from the account as and when he requires, subject to a maximum of the credit limit sanctioned to him. Such amounts
can be repaid by him as and when he has surplus funds. The borrower would be charged interest for the number of days he actually
utilized the amount each time.
 Classification of Credit Facilities ( Continued….)
3)……….. (Continued)……………………….
Let us take an example.
A business man is sanctioned a cash credit limit of Rs 10 lakhs. On 01.10.2021, he has drawn utilized Rs 3 lakhs. On
that date the credit limit gets reduced to Rs. 7 lakhs. Suppose he repaid the amount after 5 days. Then the credit limit
gets replenished back to Rs 10 lakhs. If there are no further drawings in the account during the month, he would be
charged interest during the month on Rs 3 lakhs for 5 days only, and not on the entire amount of credit facility, i.e., Rs
10 lakhs. Hence business people prefer cash credit / overdraft facilities rather than term loans.
4)Letters of Credit: Letter of credit is an undertaking given by a banker at the request of its client (who would like to
buy / import goods), assuring seller / exporter that he would get payment, subject to submission of certain documents
specified in the letter of credit. Thus L.C establishes an irrevocable undertaking by the Bank to compensate the seller /
exporter on accomplishment of the terms and conditions of the L.C. This contract between the bank and seller /
exporter, is independent of the contract between the seller and the buyer (Exporter and Importer
5)Bank Guarantee: It is the irrevocable undertaking given by a bank, at the request of its client, in favour of a third-
party beneficiary (Normally the Government), that the Bank would compensate the beneficiary of the Bank guarantee,
if the beneficiary suffers any loss on account of non-performance or improper performance of the contract by the client.
Normally Government departments ask for Bank guarantees, when they allot public works to contractors.
 Term loan vs Cash Credit / Overdraft

• In cash credit / Overdraft, the borrower, pays interest for the amount
utilized by him and , for the period he actually utilized the credit from
the credit limit sanctioned to him by the bank.
• In case of term loan the borrower has to pay interest on the entire
balance outstanding in the loan account less repayments made by
him , if any.
• In view of the above , borrowers prefer cash credit / overdraft type of
credit facility, where as banks prefer sanction of term loan
 Calculation of Interest in Cash Credit A/C
Credit Limit 80 Lakhs P T

Dr Cr Dr Bal Days
April 1.4.20 20 20 27
28.4.20 20 Nil
May 0
June 2.6.20 10 10 6

8.6.20 8 Dr 18 7

15.6.20 12 30 10

25.6.20 20 Dr 10 6
 INTEREST CALCULATION : TERM LOAN ACCOUNT
Term Loan 80 Lakhs
Rate of Interest 13%
Repayment Schedule: Rs 5 Lakhs PM
Date Dr Cr Bal
1.4.20 80 Dr 80 30

1.5.20 5 Dr 75 61

1.6.20

1.7.20 10 65
 Credit Evaluation
Cardinal Principles of lending, 6 Cs and 4 Ps, Loan Appraisal Methods.
 CARDINAL PRINCIPLES OF LENDING
• SAFETY
Bank is a financial intermediary. It does not lend it’s own funds. It lends the funds
borrowed by it from public, which are required to be repaid by the Bank as and when
demanded by the customer. Hence, it is the fist and foremost duty of the Bank to
ensure that , the depositor’s funds are safer in the hands of the borrower.
• SECURITY
The loans given by the Bank, are backed by either primary or collateral security, which
acts as a fall back, in case the borrower defaults to repay the loan.
• LIQUIDITY
Bank has to repay the deposits accepted by it from public on demand. But the loans
given by the Bank are not repayable by the borrowers on demand.they are repayable
as per the repayment schedule. Liquidity refers to repayment of the loan installments
on due dates.
• PROFITABILITY
A Bank should be commercially viable to survive. Despite social obligations, a Bank
should earn profit. A Bank should earn profit , and maintain capital of it’s own which
is sufficient to absorb the probable loan losses.
 SIX Cs OF LENDING
• CHARACTER
A person having character and integrity, would repay the loan. He may delay the repayment of
loan installments on account of bonafides reasons, but never becomes an intentional defaulter.
• CAPACITY
A person having the capacity to run the business/ industry , would earn enough profit and get
capacity to repay the loan
• CAPITAL
Capital is the owner’s contribution in the business. Capital determines owner’s stake in the
business. A Bank shall have enough capital to absorb its probable loan losses.
• COLLATERAL
Primary security is the security created out of the bank loan proceeds. Any security, taken in
addition to the primary security is called collateral security. Securities are taken as a fall back for
liquidation of a loan if the borrower defaults repayment of the loan.
• CONDITIONS
Environmental conditions and compliance of the terms and conditions of a loan are very important
in credit management.
• COMPLIANCE
Compliance with RBI, Government and Bank regulations / guidelines
Identify the “C” of 6 Cs in the following statements?
• Raghav works in IT industry. His income is volatile.
• Madhav is funded 85% of property value from the bank towards his
new property purchase, 15% is his contribution
• Mr. Bhat made multiple enquiries with various financial institutions
for obtaining a personal loan before he reached ANZ for a home
loan.
• Mr. Patnaik is willing to refinance his loan and bring in his property.
• Customer contribution is required while taking a loan from Bank
for purchasing the property. This represents…… ?
Loan to value ratio
• A Bank sanctioned Rs 40 lakhs to Mr. Krishna to purchase a
vehicle worth of Rs 50 Lakhs. What is the LTV for the loan?

• Mr and Mrs Raj have applied for a loan of $800,000 to purchase

a property worth $850,000. They are getting their existing
property worth $600,000 as additional security which has an
existing loan of $200,000 secured against it. What will be the
overall LVR/LTV for the loan?
 FOUR P’s OF LENDING
• PERSON
Ascertaining the character and integrity of the borrower, is very important in
the credit appraisal process.
• PURPOSE
A loan for productive purpose, helps generate income , and enables the
borrower to repay the loan. Hence purpose is very important in appraising a
loan account.
• PROSPECTS
If the activity for which the loan sought has demand, and is likely to thrive in
future, it would yield profits and enables the borrower to repay the loan.
• PROFITABILITY
A loan account should yield income to the lender, other wise it would become a
drag on the capital and profitability of the Bank
 CREDIT APPRAISAL PROCESS
01 KNOW YOUR CUSTOMER
02 Prima facie the borrower is eligible for the loan
03 Application for Advance – Completion with full details
04 Basic Documents
 Documents of Identity – ( Aadhar, Voter ID, PAN) and Address Proof.
 In case of Business loans, Registration certificate from Local Authority and non-domestic electricity
connection proof
 Lease / Rental Agreement
 In case of loans against property- Tax paid receipts for (3) years
 Documents of Constitution – Partnership deed, MOA, AOA, etc
 Income Tax Assessment Order for the last (3) years
 GST / Sales Tax Assessment orders
 Salary Certificate in case of personal loans
 Financial statements for past (3) years & projection for (3) years 
05 Verification in the Defaulter’s lists
* RBI defaulter’s List , * RBI wilful defaulter’s list, * CIBIL’s data , * ECGC caution list
06 Expert’s reports :* Project estimates. * Valuation of properties offered as security
* Legal opinion on title of the properties offered as security.
07 EIC ANALYSIS : Economy , Industry and Company analysis
 ANALYSIS OF A PROPOSAL
01 Technical Usage of existing technology for undertaking the project.
Feasibility Availability of Technical expertise to handle the
machinery.
02 Financial Sources and uses of funds, Surplus of income over Cost
Feasibility
03 Economic Whether the economic benefits of the project exceed its
Viability economic costs, when analysed for society as a whole?

04 Profitability Is the profit generated commensurate with the assets

deployed and efforts undertaken?
05 Overall Bankability of a project is the level of willingness of
Bankability prospective lenders to finance the project
Source: PPP Bankable Feasibility Study: A Case of Road Infrastructure Development in North-Central Region of Nigeria : By Mudi Adamu and Adamu Fatima Monisola
 BASIC CONSIDERATIONS IN A PROPOSAL
1) Whether the borrower is competent to enter in to a contract.
2) Whether the purpose of the loan is legally valid?
3) Whether the funds of the depositor would be safer in the hands of the
borrower?
4) Whether the business earns sufficient income to repay the bank dues?
5) Whether the borrower is offering adequate primary security, secondary
security and third party guarantee.
6) Whether the documents obtained are capable of charging the assets given
as security and bind the borrower and the guarantors / sureties.
7) Whether the amount of the loan installment and the periodicity of
repayment commensurate with the income generation period of the
borrower.
 MODEL BANK, HYDERABAD Main Br :: APPRAISAL OF LOAN PROPOSALS
01 Name of the borrower  

02 Father’s Name  

03 Age  

04 Occupation  

05 Place of Working  

06 Annual Income  

07 Guarantor for the loan  

08 Purpose of the Loan  

09 Cost of the Vehicle  

10 Margin (%)  

11 Loan to Value Ratio (%)  

12 Amount of Margin for loan  

13 Amount of the Bank Loan  

14 Period of Repayment  

15 Rate of Interest  

16 Equated Loan Installment(EMI)  

17 Primary Security for the Loan  

18 Secondary Security for the Loan  

19 The nature of charge to be created on the primary security  

20 The nature of charge to be created on the secondary security  

21 The charge over the vehicle to be registered with…………  

22 Documents to be taken
    
23 Post Sanction follow up
   
24 Periodical Inspection
   
 DOCUMENTATION & POSTSANCTION FOLLOW UP
• Once the proposal is found to be bankable, letter of sanction is to be issued to
the borrower, and his consent shall be obtained for the terms and conditions
of the sanction.
• Appropriate documents to bind the persons ( Borrowers and Guarantors/
sureties) and the properties offered as securities shall be obtained.
• The loan documents are to be adequately stamped.
• The documents are to be registered at the appropriate authority where ever
required ( Vehicles with RTA office, Mortgage charge with sub-registrar’s
office)
• The documents are required to be identified / witnessed wherever required.
• The end use of the loan proceeds is to be ensured.
• Inspection of the goods / machinery / vehicles offered as security is to be
done periodically.
• Stock statements , valuation reports are to be obtained periodically.
 CHARGES
1) FIXED CHARGE: A fixed charge is attached to an identifiable asset at creation. Assets can include land, property,
machinery, etc.
2) FLOATING CHARGE: While a fixed charge is attached to an asset that can be easily identified, a floating charge
is a charge that floats above ever-changing assets. Assets include Plant and machinery, Furniture and fixtures etc.,
3) FIRST CHARGE: The Bank, which financed against an asset, will have first priority for payment at the time of
liquidation of the asset.
4) SECOND CHARGE :When a Bank finances against an asset against which some other Bank has already financed,
such Bank will get second charge: “Bank A” financed against the security of a property. It will have first charge over
the property. Subsequently , if “Bank B” also finances against the same property, while the loan of “Bank A”, is
outstanding, “Bank B” will have second charge. It means that, in future, if the property is to be sold for the
liquidation of the loan, the sale proceeds will be appropriated for closing the loan of “Bank A”, the left over sale
proceeds would be available to “Bank B”
5) PARI PASSU CHARGE: ( On equal footing). When two banks finance against the same property, if both the banks
have equal rights over the property, in the proportion of their lending, it is called paripassu charge.
  SECURITY CHARGE
1 Vehicles (To be used by the Borrower) Hypothecation
2 Stock in trade, in possession of the Borrower Hypothecation
3 Stock under lock and key of the Bank Pledge
4 Golden Jewellery Pledge
5 Machinery in the Factory of the Borrower Hypothecation
6 Building (Flat or Independent House) Mortgage
7 Open Land / Agricultural Land Mortgage
8 Tractor financed Hypothecation
9 LIC Policy Assignment
10 Book Debts Hypothecation/Assignment
  SECURITY CHARGE
11 National Savings Certificates Pledge
12 Government Securities / Bonds Pledge
13 Standing Crop Hypothecation
14 Milch Animals (Sheep, Cows) Hypothcation
15 Pump sets (Agricultural) Hypothecation
16 Bank Term Deposits (Loan against FD) LIEN
17 Transfer of a Term Deposit Assignment
18 Shares Hypothecation/Pledge
19 Debenture Mortgage
20 Stock of Vehicles with Bajaj Auto  Hypothecation / Pledge
 PERIOD OF LIMITATION
A debt cannot be a life long debt. It should either be renewed / recovered well with in specified time
• Demand Promissory Note :
3 years from date of DPN
• Term Loans payable by instalments:
3 years from due date of each instalment . .
• Mortgage:
12 years from the due date of the loan
• Any suit by State/Central Government:
30 years from the date when limitation would
• Deposit like SB, CA, FD with a Bank :
3 years from date of demand
• Execution of Decree:
12 years from the date of decree
Credit Discipline
PRICING OF LOANS
 INTEREST RATE ON ADVANCES
• A comprehensive policy on interest rates on advances approved by the Board of a Bank
• All floating rate loans shall be priced with reference to the benchmark rate.
• Banks may offer loans on fixed or floating interest rates, as their Credit Policy.
• While pricing the loans in India till 2010, banks used to take a rate as reference or
foundation rate.
• Interest rates on fixed rate loans shall not be less than the benchmark rate.
• The rates of interest for different loans were arrived at a premium to the reference
rate, depending on the risk involved in such types of loans.
• Actual lending rate = Reference rate / Benchmark rate. + Components of spread
• Example: Reference Rate +2% ; Reference Rate +4% etc.,
• Interest to be charged at monthly rests. (Exception: Agricultural advances)
• No lending below the benchmark rate.
• In India the rates of interest on loans are linked to PLR since 1990, to BPLR since
2003, to Base Rate since 2010 and to MCLR since 2016.
 PRIME LENDING RATE

• The process of rationalization of lending rates started in 1990.

• The deregulation of lending rates came in to effective from October 1994, except for small
loans of credit limit up to Rs 2 lakh.
• Prime lending rate system was introduced from October 1994.
• Prime lending rate is the rate of interest charged by Banks to their prime customers / first
class customers availing credit facilities of Rs 2 lakhs and above.
• PLR was computed by taking into account a bank’s
a) Cost of funds,
b) Transaction costs, etc.
• The PLR was initially made as the floor rate for loans above Rs.2 lakhs.
• in April 2001, commercial banks were allowed to lend at Sub-PLR rates for loans above Rs. 2
lakhs.
• Banks started quoting lower PLRs to meet competition disregarding their affordability.
• Had the system continued, balance sheets of some banks would have been in red.
 BENCH MARK PRIME LENDING RATE (BPLR)
• BPLR system was introduced in April 2003.
• It was made a reference rate.
• BPLR is computed by taking into account
(a) The cost of funds,
(b) Operating expenses
(d) Profit margin.
(d) Probable loan losses,
• Banks were advised to discontinue the system of tenor-linked PLR and adopt
BPLR to bring about transparency in the interest rate structure.
• However, the BPLR system could not meet the desired objectives due to
competitive pressures.
• When Banks started quoting sub-BPLR rates, the significance of BPLR is lost. It
paved way for Base rate system.
 BASE RATE
• It was introduced in July 2010.
• It is the minimum lending rate of bank, for borrowers of all types of loans.
• RBI provided methodology for the computation of Base rate to scheduled commercial banks
which are free to adopt their own method for its computation, provided it is in compliance
with the RBI’s methodology.
• The methodology suggested by RBI for computation of Base rate has four components, viz.,
a) Cost of deposits.
b) Negative carry on CRR and SLR.
c) Unallocatable overhead costs. and,
d) Average return on net worth.
Commercial banks are to compute and club them to arrive at their base lending rate.
• Unlike BPLR system, under the Base rate system commercial banks are not expected to lend
to any category of borrower below the specified Base rate.
• Unfortunately, some banks are declaring base rates less what it ought to be to attract more
customers, knowing fully well that such act would lead to a cut on it’s profit.
 MARGINAL COST OF FUND BASED LENDING RATE (MCLR)
The RBI directed that all rupee loans approved and credit limits renewed with effect from
April 1, 2016, should be priced with reference to the MCLR which will be the internal
benchmark for such purposes.
Banks shall publish the internal benchmark for Overnight MCLR, One-month MCLR,
Three-month MCLR, Six-month MCLR, One-year MCLR. Review of MCLR will be done
every month.
MCLR is arrived at by adding the following four components.
a) Marginal Cost of Funds: It comprises of marginal cost of borrowings, along with
return on net worth. The marginal cost of borrowings shall have a weightage of 92%
of Marginal Cost of Funds; while Return on net worth will have the balance
weightage of 8%.
b) Operating Costs: These costs are associated with providing the loan, raising funds, and
running the day to day operations.
c) Cost of Carry in the Cash Reserve Ratio (CRR): The banks have to take into
consideration the cash deposits they need to keep with the RBI.
d) Tenor Premium: This is essentially the premium that will be charged for long- term
loans to mitigate the risk associated with long-term lending.
 EXTERNAL BENCH MARK RATES
RBI made it mandatory for all banks to link all new floating rate loans (i.e. personal/retail loans,
loans to MSMEs) to an  external bench mark  with effect from 1st October 2019.
•The move is aimed at faster transmission of monetary policy rates.
•Banks are permitted choose from one of the four external benchmarks
i) Repo rate. ii) Three-month treasury bill yield, iii) Six-month treasury bill yield or
iv) Any other benchmark interest rate published by Financial Benchmarks India Pvt Ltd.
•At present, interest rates on loans are linked to a bank’s marginal cost of fund-based interest rate,
known as the Marginal Cost of Lending Rate (MCLR).
•Existing loans and credit limits linked to the MCLR, base rate or Benchmark Prime Lending
Rate, would continue till repayment or renewal.
•Those customers willing to switch to the repo-linked rate can do so on mutually acceptable terms.
•Adoption of multiple benchmarks by the same bank is not allowed within a loan category.
•The interest rate under the external benchmark shall be reset at least once every three months.
 CALCULATION OF MARGINAL COST OF FUNDS
Sl Source of funds (excluding equity) Rates offered on deposits on Balance outstanding as a Marginal
the date of review/ rates at percentage of total funds cost
which funds raised (Other than Equity)
    (0.92 * 6.25) + (9*0.08) = 6.424 [1] [2] [1] x [2]
A Marginal Cost of Deposits & Borrowings      
1Deposits      
  a Current Deposits (Core)  0  10 = 10/400 = 0.025  0.000
  b Savings Deposits (Core)  4  40 =40/400 = 0.100  0.400
  c Term deposits (Fixed Rate)  5  60= 60/ 400 = 0.150  0.750
  d Term deposits (Floating Rate)  6  60 = 60/400 = 0.150  0.900
  e Foreign currency deposits  3  30 = 30/400 = 0.075  0.225
2Borrowings      
  a Short term Rupee Borrowings  9  50 = 50/400 = 0.125  1.125
  b Long term Rupee Borrowings  8  70 =70/400 =0.175  1.400
c Foreign Currency Borrowings
including HO borrowings by foreign
banks (other than those forming part
  of Tier-I capital) 7  80 = 80/400 = 0.200  1.400
  Marginal cost of Deposits & Borrowings    400  6.250
B Return on networth  9    
Marginal Cost of Funds = (92% * Marginal Cost of Deposits & Borrowings) + (8% * Return on Net worth)
CALCULATION OF MARGINAL COST OF BORROWING
 Credit Monitoring
Preventive, Remedial and Legal Measures of Recovery
 Types of Recovery Measures
(A) Preventive Measures
Before the loan account becomes a Non-performance asset
(B) Remedial Measures.
After the loan account becomes NPA, in cases where the borrower is
not an intentional defaulter.
(B) Legal Measures
Where the loan account is not recoverable by preventive and , remedial
measures and the borrower is an intentional defaulter.
 (A) PREVENTIVE MEASURES:

1)Ensuring the end use of the loan

2)Regular post sanction follow-up
3)Periodical inspection of assets
4)ABC analysis of loans
(A)Visit frequently.
(B)Visit periodically.
(C)Visit once in a while
5) Periodical notices should be sent to the customers. They are:
(D)Ordinary notice.
(E)Registered notice.
(F)Legal notice
 
 (B) REMEDIAL MEASURES:
1)Extension of time by taking AOD (Acknowledgement Of Debt) / Revival Letter
2)Rephasement of the account ( Fixation of new repayment schedule)
3)One-time settlement ( Payment entire amount in the loan account by the borrower LESS concession
given)
a) Penal interest waiver b) Waiver of compounding interest
c) Waiver of interest partially/fully d) Partial waiver of principal
4)Lok Adalat ( Settlement of loans by conciliation)
5)Write off (Where there are no chances of recovery, loan amount due is adjusted from profits of the Bank)
6)Corporate debt restructuring (CDR) : Rephasement of company credit failities
7)Strategic debt restructuring (SDR- Debt is squared off by taking equity participation in the default
company)
8)Scheme for Sustainable Structuring of Stressed Assets (S4A)

•CDR, SDR, S4A has been scrapped off by RBI in 2018 and IBC (Insolvency and Bankruptcy Code) was
introduced in 2016 which is used as the main tool now for recovery of corporate loans.
 (C) LEGAL MEASURES:

1) Filing suit in the court of law

(A). Preliminary decree. (B). Final decree. (C) Executive petition
Remedies available are
a) Injunction b) Attachment before judgement
2) DRT (Debt Recovery Tribunal):
Cases of Banks and Financial Institutions are solved here
a) Amount due in the account should be more than 20 lakhs
b)Decides the case and attaches the property and sells
c) Time limit to decide case is 6 months

3) SARFAESI (Securitisation and Reconstruction of Financial Assets and

Enforcement of Securities Interest) Act:
Security can be sold without intervention of court